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Don't Drink The Water: Greece And The IMF

The following post is by our anonymous hedge fund manager friend, who shall remain nameless. He runs the Emerging Markets desk at his firm.

Greece CDS has traded wider this morning on comments from the Prime Minister that his government might seek aid from the IMF. This has been taken to suggest that the rest of the EU has still not yet come to internal agreement about how to handle Greece’s debt woes. That several EU countries view an IMF-led package for an EMU member as, if not a mortal embarrassment, then at least something resolutely not to be wished has raised fears that these countries, via their influence at the IMF board level, might close off even this avenue of assistance to the Greeks. Iceland might be able to tell Greece a thing or two about trying to keep an IMF program on track while suffering the wrath of several EU members.

To the extent, though, that Greece does end up getting IMF money rather than bilateral EU money, much of the commentary on the subject treats these sources of support as six of one vs. a half-dozen of the other. Experience with Emerging Markets bailouts suggests a brief corrective to this view. IMF loans are both de jure and de facto super-senior claims. Despite quite of lot of investor complaints during the IMF’s lending heyday of the late 90s (“where in the bond indenture’s negative pledge does it say except for IMF loans?!!”), sovereigns that have entered into default or pursued restructurings have afforded this super-senior treatment to their IMF debts. In the history of the IMF, only a very few countries – typically woeful failed states (e.g. Liberia) or cartoon-villain Trashcanistans (e.g. Sudan) have defaulted for more than a symbolic nanosecond on the IMF. And the IMF, for its part, has only voluntarily reduced claims in the context of the HIPC (Highly Indebted Poor Countries) initiative, and even then kicking and screaming and only with compensation from deep-pocketed members.

The standard for bilateral debts, on the other hand, is “comparability of treatment.” In practice that has meant treatment sometimes better that private debts, often very similar in NPV terms (but different in precise terms – more maturity extension and coupon reduction , less haircuts), and sometimes worse (maturity extensions without any burden-sharing from the private sector in cases where there is a political motive for support). Therefore, private-sector creditors of Greece should, ceteris paribus, prefer that Greece get bailed out by bilateral loans rather than IMF loans. The latter money could lead to effective subordination of Greek bonds. Of course, this only matters if the market believes that a bail-out doesn’t solve Greece’s problems once and for all. Unfortunately (for both Greece and its creditors), to look at the shape of the CDS curve, the market doesn’t take this sanguine view.